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Ethanol profits hinge on oil prices, government policy

The boom in ethanol has been a key driver for the agricultural sector this year — but that may not be so much the case in the years ahead, says Pat Westhoff, program director of the Food and Agriculture Policy Institute (FAPRI) at the University of Missouri.

“The long-run outlook for ethanol and biodiesel depends to a large extent on what happens in the petroleum market, on what happens with government policy on biofuels, and what happens with development of other technologies, such as cellulosic ethanol,” he told members of the Southern Cotton Ginners Association at their summer meeting at Baton Rouge, La.

A lot of research is under way on producing ethanol from cellulosic sources such as crop wastes, wood chips, and other materials, “and that could make a huge difference in what the industry will look like in years ahead,” Westhoff says.

“We can’t expect that we’ll always have high corn prices just because there’s a lot of ethanol demand. As we’ve seen this year, when it developed that the crop was bigger than anticipated, corn prices can fall. We’ve shaved more than $1 per bushel off the price in the last few weeks due to the large acreage.”

FAPRI analysts “do expect that corn prices will remain high in front of us, with $3 the norm rather than the exception over the next 10 years — if we have average utilization and current tax policies remain in place.”

Ethanol production “has really taken off over the last 12-18 months,” Westhoff says, now at about 6 billion gallons, with plants being built that will add another 6 billion gallons.

Much of that has been encouraged as a result of a government tax credit of 51 cents per gallon to blenders through 2010, “and it’s expected it will be extended beyond that.” A blender’s tax credit of $1 per gallon for biodiesel from virgin soybean oil only goes through 2008, but “we expect it will be extended, too.”

Ethanol plants already in operation have been doing well, Westhoff says. Dry mill plants (which most are) racked up an “amazing” net return of $1.56 per gallon in 2005/06, which was enough to pay off a plant in two years.

“With that kind of return, it’s not surprising there has been a lot of investment in ethanol plants.”

While returns “continue to be pretty good for the current year,” Westhoff says projections for next year indicate they “could be only one-third or less than those of 2005/06. Although there are still positive profits at current prices, (ethanol) is not quite the lucrative thing it appeared to be only a few months ago.”

For the 2005/06 corn marketing year, he says, the average price per gallon of ethanol at Omaha, Neb., was $2.51 per gallon; for the current year, $2.22. “ The Chicago Board of Trade December futures price yesterday was $1.84 per gallon, so the price has been trending downward in a pretty serious way.”

FAPRI projections point to “a very dramatic increase in ethanol production” over the next two or three years, he says, “but unless we see much higher petroleum prices or a change in government policy, we don’t see much additional expansion beyond that. Once the plants on the drawing board come online, that may be about it.”

The U.S. has seen “a much larger shift to corn and soybeans and away from cotton than we’d anticipated earlier this year,” Westhoff says. “We’ve seen a huge run-up in soybean oil prices over the last few months due to biodiesel.

“Because of their higher production costs, a lot of biodiesel plants are operating at very little, if any, profit margin, and that could get even more dicey if we were to see a drop in diesel prices in the years ahead.”

Loss of government tax credits could see revenues decline for ethanol and biodiesel plants and an increase in price to the consumer, he says. “The net result would be a lot smaller industry.” Ethanol production could drop by a third, “biodiesel production would pretty much dry up,” and corn prices would decline, with more acres likely going back to cotton.

The Congress has approved a mandate for 15 billion gallons of biofuel use by 2015, with a further increase to 36 billion by 2022.

But, Westhoff notes, all the increase after 2015 is to come from cellulosic ethanol and other advanced biofuels.

“Under this scenario, corn prices on average would be higher than otherwise. Petroleum prices would make a big difference. If oil price hit $80 per barrel and stayed there, or went higher over the next 10 years, it would result in a very large ethanol industry.”

Cotton will continue to be more dependent on government farm programs than corn, Westhoff says. “After the very large reduction in cotton acreage this year, I think we’ll see a tiny uptick in 2008/09 and a sight pullback in corn.

“We’re almost certain to see a continued decline in U.S. mill use of cotton, but the bright spot is that exports will increase. With more exports and a smaller crop, we’ll see a significant drop in ending stocks this year. We’re projecting an average price for 2007/08 of 54.5 cents per pound and 60.9 cents for 2008/09.”